Is the Telecom Industry a good bet now?

The whole country is currently talking about the exorbitant prices at which the 3G spectrum bandwidth has been sold to the telecom players in India. The big boys (Airtel, Vodafone, Reliance, Idea, TATA etc) have accepted to shell out thousands of crores of rupees to get their share of the apple. Some of us who have already made our trips to USA or any other developed country are already muttering, boss, 3G is the baseline standard there and people are talking about moving to 4G right now. Unfortunately my friend, the spectrum allocations have just been completed for 3G and it will take years of effort and millions of dollars before which the telecom players would be fully prepared/able to move forward to the next step which is 4G.

Ok, coming back to the topic, with telecos spending so much of money for the 3G spectrum, many of the investors are thinking, is this the right time to enter telecom stocks? The valuations are pretty low (due to the market correction over the past few months) and a mobile phone has become a bare minimum necessity for everyone, shouldn’t we be entering telecom stocks to make some good buck right now?

I don’t want to give a straight answer right away. Let’s dig deeper in the whole situation and as smart investors we must be able to come to a conclusion at the end of this article.

Note: This article is going to be a pretty long one. I can give an answer in one sentence but I personally feel that as investors we must know the reasons and facts before taking a decision and hence this lengthy article.

Below are the points we are going to consider:
1. Competition
2. Government Rules
3. Cost of 3G spectrum
4. Cost of 3G infrastructure

Competition:

India is the one country where we have more than 10 telecom operators in major cities. We have Airtel, Aircell, Vodafone, Idea, Uninor, TATA Indicom, Virgin Mobile, TATA DOCOMO, Videocon Mobile, Reliance Mobile and so on. I intentionally left out BSNL because it is a government entity and immaterial of the profit or loss it makes, it’s going to survive and hence I feel there is no need to discuss about it at this moment.

With 10 people fighting it out, a customer who wants a new mobile connection would want the best deal for every single penny he is going to spend. With this competition comes cut throat pricing. As every operator comes up with an innovative/cost effective plan to attract prospective customers, his competitor would go one up and offer even better schemes. This game of one-upmanship is going to go on...

In developed nations usually we have only 2 or 3 major operators who hold more than 75% share in the market and we also have 2 or 3 smaller boys fighting for the remaining 25% share. Unfortunately in India we have 10 or more guys fighting it out and hence this super stiff competition.

As a Customer: This is extremely good for us because we get a good value for our money
As an Investor: this is really bad because companies would be going at leaner profit margins and hence the amount of profit we can make out of them may be limited.

Government Rules

The Indian government came up with radical measures a decade ago to promote the usage of mobile phones and the telecos grew at a breathtaking speed. But now, with the new regulations with respect to sharing of the 3G spectrum and other telecommunication bandwidths, operators are going to find it harder and harder to cost effectively utilize their networks. Irrespective of the size of the operator and his customer base, the government has an upper limit on the max bandwidth an operator can use and hence it is going to be even tricky. The bandwidth is distributed proportionately among all the 10+ operators and hence the extra large players like Airtel or Vodafone do not get a bigger piece of the pie.

Every operator would want to retain its most profitable customers who form nearly 20% of its revenues. These are high end users (usually businessmen and other influential people) who use their mobiles extensively. With increasing number of users, the network is bound to get clogged and such customers may opt to choose a different provider thereby shifting the revenue to a different operator. At the same time, if operators reserve bandwidth for these guys, the remaining 75% or more customers are going to move off due to clogged networks because of bandwidth reservations for the big men. It’s a tough trade off for the operators which they must handle efficiently in order to maintain their profits.

As a Customer: Even if the networks of the big boys get clogged due to extensive utilization, we can shift to the smaller boys to continue our mobile usage.
As Investors: Big boys are listed in the stock market and if they start losing their customers it is going to reflect badly on their balance sheets and in turn going to affect our profits.

Cost of 3G Spectrum:

The government has made thousands of crores of money as part of this spectrum sale and the telecos are shelling out Rs. 10,000 crores or more (the big boys) for their share of the spectrum. That is a lot of money. Operators would want to pass on this cost to the customers who want to use 3G and many of us would not be willing to pay up such money and may opt to remain in 2G system, which means operators, may find it difficult to break even on the cost they incur in this spectrum purchase.

As a Customer: We have a choice, we can either pay up and start using the superior 3G technology or remain with the 2G option and opt to move on to 3G a few months down the lane when the price of 3G would come down.
As Investors: This multi-thousand crore expense is a liability in the balance sheet which will severely affect the company’s earnings which in turn is going to affect our earnings as share holders.

Cost of 3G Infrastructure:

Just by getting the spectrum, operators cannot start using the 3G system. They have to upgrade their existing technologies to work with 3G capabilities which means a further few hundred crores of expenditure to support the 3G network. Again this cost would be passed on to the customers who want to use 3G system.

As Customers: This cost would in turn be passed on to us; hence 3G may be an unreachable grape for many of the middle class foxes like us

As Investors: Further expenditure in the balance sheet is definitely not going to do any good for the company’s profit. Companies may take loans to meet this expenditure which may increase their debt to equity ratio which effectively is going to directly affect our profits by holding the shares of that company.

Conclusion:

As I said in each of the sub sections, this upgrade to 3G may not be so profitable/rewarding for investors. Many wealth managers are exercising/advising caution to their customers who wish to enter teleco stocks.

If you are a new or small investor it is better to wait and watch and gain exposure to these stocks after a few months based on their performance. For seasoned investors, you can exercise your judgement and decide to buy/sell/hold these shares.

Finally to wrap up, a buy or sell suggestion is very easy but as always our Indian stock market has been giving its share of surprises to the Indian investor population. Hence we have to wait and watch what happens.

Happy Investing!!!